The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Friday, March 16, 2012

The International Financing Review ran an article on how structured finance investors and issuers were being offered an incentive scheme to buy shares in the ECB endorsed Euro ABS Data Warehouse (ED).

This is a classic case of the sell-side treating investors as muppets.

Regular readers know that your humble blogger has explained why no matter how many times the ECB relationship is trotted out this particular sell-side sponsored initiative is not going to end the buyers' strike in structured finance.

However, for new readers, it is worth reviewing why this initiative should fail.

The European Data Warehouse (ED), which will hold loan-level data on securitisation deals, is moving closer to completion. And its backers are offering prospective investors a progressive discount pricing scheme for accessing to the data in a final push to get it ready.

The construction and running costs of the ED are being funded by a share placement scheme.

Potential investors are being offered a total 85 shares, a maximum five each, at €250,000 each to raise €21.25m of capital.

Discounts are now being offered for buying more shares, starting at 5% for one share, 12.5% for two, 25% for three, 40% for four and a maximum 65% saving for institutions purchasing five shares.

In nominal terms, the subscription fee for large data users start at €1,030, declining to €361 with the biggest discount rate. Users’ costs could fall to €8, for each download, if they receive the maximum discount from €24 for non-shareholders.

Data providers’ one-off registration fee per new ABS could drop from €17,000 to €5,950 under the proposed scheme.....

Before I discuss the data that is going to be made available, what is important to note is that the business model of the ABS data warehouse assumes that the buy-side should and will pay for data.

Is this a good assumption?

It depends. If all of the buyers for a deal are in Europe, maybe. If any of the buyers of the deal are in the US, no.

A little background is necessary to understand this answer.

To optimize the proceeds and minimize the cost to the issuer, each individual structured finance security is designed to appeal to as broad an investor base as possible. Where a broad investor base includes investors in different geographic locations -- look at how many European investors owned US sub-prime mortgage backed securities.

If a European issuer's security is to appeal to US based investors, it must comply with US security regulations. At the top of the list of US security regulations is a regulation, Fair Disclosure, that says that an issuer cannot discriminate between investors based on the investor's ability to pay for data. In short, all US investors have to be able to access the data at the same time for free.

Hmmm...if investors in the US get the data for free, then why would a European investor pay for data when they can access it for free in the US? If the European investor is willing to pay, why would they not pay Bloomberg who gets the data for free in the US?

Hmmm...if the issuer doesn't have US investors, how attractive is it to do the deal?

Prospective investors in the warehouse were invited to a conference call at 14:00 GMT on March 15, and have until March 20 to submit binding interest.

Just like the short sell cycle for the structured finance securities that caused all the problems with the financial system, clearly there is a need for a fast close so that investors have little time for due diligence into whether an investment makes sense or not. But investors are muppets....

However, the potential investors must be doing some due diligence as there has been an upswing in the number of readers who looked at my previous posts on the Euro ABS data warehouse.

It is anticipated that RMBS data will be lodged with ED in the second or third quarter of this year, followed by CMBS and SME loans during the closing quarter of the year.

The plan is for the warehouse to be fully ramped up and functioning by 2014 with around 1,000 ECB-eligible transactions whose data will be updated quarterly. The reporting of auto loans, consumer finance and leases may not start until 2014, however.

Central to the data warehouse's business plan is providing data that will be updated quarterly. This is the data that investors will be paying for.

This comparison bears repeating. The data warehouse is going to update data less frequently than opaque, toxic RMBS securities do.

Let me try to put this in terms that a muppet can understand.

The physical equivalent of bundling loans together and putting them into a trust for the benefit of the investors, is putting these loans into a bag.

From the investor's perspective, in order to know what they own (see Article 122a of the Capital Requirements Directive) they have to know what is currently in the bag.

Providing updated data once a quarter is the equivalent of having the loans in a closed brown paper bag. No one can see their current condition.

Since investors do not know the current condition of the loans, they are reduced to blindly guessing when they try to value a security with quarterly data. This is not consistent with knowing what you own.

If the data warehouse provided updated data whenever an observable event (including payment, delinquency, and default) occurred with the underlying collateral, then investors would know the current condition of the loans. Knowing what they own requires having the loans in a clear plastic bag.

Are investors really going to spend money on worthless data?

Full disclosure. My firm has patents which covers observable event based reporting by an ABS data warehouse providing this type of information to US investors. While the patents use medical receivables as an example for observable event based reporting of ABS data, many of the claims are general and apply to any asset that is used as collateral for a structured finance transaction.

The ED is an integral part of the ECB’s desire to restore confidence in the securitisation market.

When the central bank announced the data initiative in April 2011, it said it “firmly believes that this initiative should facilitate investment and support transparency, integrity, and restore confidence in the structured finance markets as well as aid the simplification of data processes in the industry by ensuring investor access to comprehensive and standardised information across the European ABS market.”

It is clear that the ECB would like to have the securitization market restarted as it is currently the primary source of funding for these deals in the Eurozone. The buy-side is on a buyers' strike.

However, there is no reason to believe that without offering observable event based reporting the Euro ABS data warehouse will end the buyers' strike.

The ED product features among a recent batch of initiatives that are showing ABS in a more positive light. The question is whether it will help to resurrect the sector in the eyes of investors whose faith in the product has been rocked following the financial crisis.

The ED complements the Prime Collateralised Securities (PCS) plan from AFME and the EFR, which could benefit from a regulatory reprieve.

Like the PCS, ED is a sell-side led initiative.

The first clue that the buy-side did not drive the Euro ABS data warehouse is the plan to charge the buy-side for data.

The PCS objective is to create a high quality label for European securitisation, with the hope that it could be considered eligible for liquidity buffers under CRD IV.

And the potential for that has increased following the European Commission’s latest draft of the document (published March 1) which asked the European Banking Authority to consider RMBS in its definitions of high quality and liquid products.

Adding a label as PCS proposes does not change whether an investor has access to the data they need in order to know what they own.

Adding a label is simply a sell-side effort to repackage a skunk by calling it Pepe Le Pew and hoping, like the cartoon character, that no one notices the smell.

Although constructed independently, the PCS and ED process could work together. The PCS can provide ABS with the stamp of high quality it needs, while deals qualifying for it will probably have to be logged with the ED in order for the ECB to achieve its aim of loan-level data analysis.

The bottom line is that the sell-side thinks the buy-side is composed of muppets and will end its buyers' strike for a few meaningless cosmetic changes.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.